hard · Quantitative Finance
A trader observes that two assets have a high Pearson correlation but no tail dependence.
Which copula model is likely being used, and why is this potentially dangerous for risk management?
- Archimedean copula; it is only valid for assets with identical marginal distributions.
- Gaussian copula; it assumes that extreme events in the tails become independent, underestimating joint crash risk.
- Student-t copula; it fails to capture the linear correlation between the assets in normal market conditions.
- Clayton copula; it overstates the correlation of positive returns while ignoring negative tails.
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